C-store Industry M&A May Feel Trump Effect
President Donald Trump is getting ready to enact sweeping changes to the federal tax laws in the United States and the regulatory code that was implemented during the past eight years under President Barack Obama.
The new President’s tax and regulatory plans closely mirror the blueprint for reforming most of the federal tax code, and revising or eliminating numerous federal regulations proposed by Republicans in the House of Representatives during the 2016 election cycle. The House blueprint for the economic revival of the U.S. economy is referred to as "A Better Way." It is widely believed that House Speaker Paul Ryan will lead the new Administration’s legislative initiatives in Congress, and any final legislation will include most of the key tax and regulatory concepts included in "A Better Way."
While the business community is almost universally cheering on these anticipated policy proposals, it is too early to fully understand how President Trump’s plans will actually impact each sector of the U. S. economy and, more specifically, the rapid consolidation that has been occurring in the convenience and gas (C&G) industry over the past several years.
Listed below is a brief summary of some of the major policy proposals the unified Republican government hopes to pass in the first year of the new President’s term, and how these stimulative initiatives may impact the overall U.S. economy and the C&G industry in particular.
Reform of the U.S. Tax Code
The overall goal of the tax plan outlined in "A Better Way" is to greatly simplify the U.S. tax code and vastly reduce federal tax rates for individuals and corporations. President Trump also campaigned on a platform to lower the federal tax rate for corporations to 15 percent, including pass-through entities. These dual goals of lower rates for individuals and corporations were widely discussed and covered during the recent presidential campaign. The business community has also been stressing for some time that the federal tax code needed to be reformed, as the country’s outdated tax system was actually stifling economic growth.
However, what has not received as much attention are many of the proposed details in the Republican House of Representatives plan that will impact merger and acquisition (M&A) activity in the U.S. For example, the House plan would eliminate the current deduction for debt payments for all businesses. Leverage has long played a major role in most acquisitions in the U.S., in part because interest payments are currently tax deductible.
"A Better Way" would also eliminate depreciation, and instead, a buyer of real estate assets would be able to treat the entire cost of acquiring property, excluding land, as a business expense that could be used to reduce taxable income.
It is certainly too early to tell how these interrelated revisions to the tax code will impact every industry or company. In addition, companies that recently completed major acquisitions are concerned about how the elimination of depreciation and interest payments would be phased in under any new law.
The large C&G consolidators that have completed numerous acquisitions during the recent merger mania in the industry may all of a sudden lose their previously anticipated tax deductions, which will certainly increase future taxable income and offset some of the positive benefits of the lower tax rates. How all of these tax changes will impact each company and sector of the economy is far from certain.
New Interest Rate Environment
In December 2016, the Federal Reserve showed increased optimism in the U.S. economy’s outlook and raised the federal-funds rate by 25 basis points — only the second rate increase the Federal Open Market Committee (FOMC) has approved in a decade. Many members of the Fed’s board of governors have commented for years that Fed monetary policy alone could not revive the historical rate of economic growth in the U.S. economy, and that major fiscal and regulatory reforms at the federal level were needed to achieve this goal. Until these types of reforms are implemented, most economic experts have assumed that the Fed would move very slowly and cautiously toward removing what has been an unprecedented level of monetary stimulus from the economy since the Great Recession that started in 2007.
Numerous economists are now predicting that the Fed may have to raise interest rates faster and higher than currently forecasted if the U.S. Congress quickly passes many of the tax and regulatory reforms that are being advocated by President Trump and House Speaker Ryan, and the outlook for faster economic growth quickly materializes.
Fed Chairwoman Janet Yellen, in her December press conference announcing the federal-funds rate increase, was unwilling to attribute any of the Fed’s more bullish forecasts to Trump’s election as President of the United States. She indicated a desire to adopt a more wait-and-see approach to its actual impact on the economy, and ultimately, Fed policy. However, the post-election increases in the U.S. stock markets and longer term market interest rates certainly tell a different story. For example, the yield on the 10-year Treasury Note climbed by 84 basis points in the last quarter of 2016, the largest quarterly gain since 1994.
Many Fed watchers are wondering out loud if the Fed is still acting too cautiously and running the risk of letting the economy overheat and inflation take off. Keep in mind, the Fed is currently forecasting the federal-funds rate will rise by only 75 basis points in 2017. This forecast is only 25 basis points higher than the Fed’s pre-election assumption.
Many companies in the C&G industry that completed numerous acquisitions during this period of historically low interest rates may now face the unanticipated risk that the cash flow needed to service their current debt payments has been vastly underestimated. This new reality could be especially painful for some of the larger master limited partnerships (MLPs) that are already under market pressure to lower their overall level of existing debt.
New Regulatory Environment
President Trump’s picks of Oklahoma Attorney General Scott Pruitt to lead the Environmental Protection Agency (EPA) and businessman Andy Puzder, chief executive of CKE Restaurants Holdings Inc., the parent company of the Carl’s Jr. and Hardee’s burger chains, to be Labor Secretary were positively received by most members of the business community.
Puzder has been a vocal advocate for cutting back or eliminating many of the new labor regulations passed during the Obama Administration. He has also argued against raising the federal minimum wage higher than $9 an hour, far less than the $15 an hour most Democratic members of Congress are currently proposing.
Since minimum wages will increase in 20 states in 2017, impacting approximately 4.4 million workers across the country, the business community could certainly use a forceful advocate in the executive branch of government to publicly speak about the negative economic implications of higher minimum wage laws. The progressive forces in the U.S. are currently winning the minimum wage debate all over the country. For example, the voters in the very red state of Arizona passed a $1.95 increase in November. The increase, which went into effect on Jan. 1, 2017, brought the state's minimum wage to $10 an hour, one of the largest one-time increases ever enacted in any state.
One of the first tests of new Labor Secretary Puzder’s influence in the Trump Administration will concern the revised federal overtime rule the Obama Department of Labor approved in 2016 that nearly doubled the salary threshold from its current $23,360 to $47,476, under which virtually all workers will be eligible for time-and-a half pay starting in 2017. The overtime rule has a real economic impact on the C&G industry in particular.
Its implementation was temporarily blocked nationwide in November 2016 by an injunction ordered by a U.S. District Judge in Texas. President Obama’s Department of Labor filed an appellate brief with the U. S. Court of Appeals for the Fifth Circuit to overturn the injunction. An oral argument on the case was slated for shortly after Trump took office.
Puzder has written extensively about the negative impact of the new overtime rule, and the business community is expecting the Trump Administration will decide to drop the current appeal and let the injunction stand until a total review of the new labor regulations the Obama Administration has proposed or passed has been completed.
If Puzder’s views prevail, this will be very bullish for the C&G industry and should help to restrain the growing cost of skilled labor. However, is the new President who ran on a populist platform going to stop millions of American workers impacted by this new rule from receiving a much anticipated wage increase? One thing President Trump has proved since he announced his candidacy is his unpredictability.
The new head of the EPA, Pruitt, comes from an oil and gas state and has been clear about his opposition to the increased use of ethanol and other biofuels in the U.S. fuel supply. He has called the current Renewable Fuel Standard (RFS) totally unworkable.
Carl Icahn, the newly appointed special advisor to President Trump on regulatory reform, is the controlling stockholder in the merchant refiner CVR Refining and also a vocal advocate for reforming the RFS. According to Icahn, the RINs market that was created as part of the Renewable Fuel Standard is full of rampant fraud and abuse, and the market distortions it causes are driving the entire independent refining industry in the U.S. into bankruptcy.
However, candidate Trump expressed his full and 100-percent support for the current ethanol mandates while campaigning in Iowa and other corn-producing states. How President Trump decides to settle this obvious conflict within the Administration could have a major impact on the motor fuels market in the U.S. and the competitive advantage the current RFS system has offered many of the largest marketers in the country.
If President Trump decides to actually reform the RFS in a way that leads to a collapse in current market value for RINs credits, the pricing and wholesale margin advantage many of the leading M&A players in the C&G industry have enjoyed over the past several years could start to disappear.
Finally, it will be especially interesting and important to see how the new President’s stated goals of reversing most of the Obama Administration’s regulatory agenda, which has impacted the entire petroleum industry, and further expanding energy production in the U.S. will impact the worldwide market price for crude oil.
A single article cannot cover all of the policy initiatives the Trump Administration is expecting to focus on in the coming years that will impact our industry and its ongoing consolidation. Most importantly, given President Trump’s unconventional approach to campaigning, interacting with other public officials and communicating with the American people, we may all be in for a wild ride.
Editor’s note: The opinions expressed in this column are the authors’ and do not necessarily reflect the views of Convenience Store News.